Volatility for many public companies is just an earnings report away.
That’s the lesson learned from Digital Insight Corp., one of the largest providers of Internet banking and bill-pay services, whose shares plummeted 30 percent in late July, erasing $330 million of shareholder wealth in a two-day period.
Digital Insight provides a unique view into what happens when a company’s Internet business model, which, similar to Netflix, is based on recurring revenue from online subscribers, suddenly shows signs of a slowdown.
Though Digital Insight posted an 18 percent jump in second-quarter revenue, it had flat earnings and investors rushed to the exits once a key metric for the firm’s online traffic turned south.
Erik Randerson, the Calabasas-based firm’s director of investor relations, admits he was surprised the stock got whacked for reporting a substantial drop in the number of new subscribers for its highly-profitable bill-pay services.
Digital Insight added 66,000 online bill-pay users in the second quarter, down from an average of 125,000 over the previous three quarters. Randerson said bill payment is not slowing and the figure was an aberration for the quarter, caused by increased merger activity among small banks.
“By all accounts, this earnings season has been extremely volatile and the growth companies with higher multiples like Digital Insight that have disappointed have really been hammered,” Randerson said.
At the same time, Digital Insight said that a rise in merger and acquisition activity among its small-bank customers led to the loss of 15 bank clients, a high attrition rate. The stock market’s choppiness and a shift by institutional investors to large cap stocks compounded the company’s stock woes.
Overblown sell-off?
Before the stock took a dive, Digital Insight had been trading at a multiple of 30 times its 2006 earnings estimates as measured by First Call, a unit of Thomson Financial. The high multiple meant investors had expected the company to beat estimates and also raise its guidance for the year. When that didn’t happen, shares fell 30 percent to $22.11 a share, from $31.65 a share a share on July 26.
Not surprisingly, two analysts immediately upgraded the stock, characterizing the sell-off as overblown.
Nik Fisken, a managing director at Stephens Inc., upgraded shares to “overweight” with a price target of $36 a share. John Kraft, a research analyst at D.A. Davidson & Co., upgraded the stock to a “buy” rating from “neutral,” with a price target of $35 a share.
“Their valuation was high and people questioned how long they could earn 45 percent gross margins being a reseller,” Fisken said, noting that Digital Insight resells the services of two large bill-pay technology companies to 1,750 small and mid-sized banks and credit unions.
Bank of America is the 800-pound gorilla that radically changed the sector by offering free online banking. As a result, bill-pay features have grown in importance for banks trying to lure customers.
In order to compete, small banks and credit unions that can’t invest in technology have turned to outsourced services by Digital Insight.
The company’s business model is based on long-term subscription contracts and a recurring revenue stream. Digital’s clients pay the software provider user or transaction fees of roughly $1 per month for basic online banking access and another $4 per user for bill-pay services fees that fall directly to the company’s bottom line.
Online banking and bill-pay may seem like a way of life for many bank customers. Still, the statistics show that two-thirds of bank customers have not adopted online services so the potential is high. Of its 1.6 million-customer base, Digital Insight has signed up only 4.4 percent for bill-pay services, compared with 20 percent for Bank of America, said Fisken of Stephens. Still, the total number of potential bill-pay subscribers is 36.8 million.
Merger activity means that not only is Digital Insight facing a shrinking base of customers, but competition could erase its once-exclusive arrangement with technology providers.
One important reseller, Fidelity Information Services Inc., a unit of title escrow giant Fidelity National Financial Inc., announced it is rethinking its strategy of selling its services to Digital Insight. In 2004, Fidelity National bought Aurum Technology Inc., turning Fidelity into one of Digital Insight’s largest competitors.
